PJSC LUKOIL MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Transcription

1 PJSC LUKOIL MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS For the three-month periods ended 31 March 2017 and 2016

2 The following report contains a discussion and analysis of the financial position of PJSC LUKOIL at 31 March 2017 and the results of its operations for the first quarter of 2017, compared to the first quarter of 2016, as well as significant factors that may affect its future performance. It should be read in conjunction with our International Financial Reporting Standards ( IFRS ) condensed interim consolidated financial statements, including notes. References to LUKOIL, the Company, the Group, we or us are references to PJSC LUKOIL and its subsidiaries and equity affiliates. All ruble amounts are in millions of Russian rubles ( RUB ), unless otherwise indicated. Income and expenses of our foreign subsidiaries were translated to rubles at rates which approximate actual rates at the date of the transaction. Tonnes of crude oil and natural gas liquids produced were translated into barrels using conversion rates characterizing the density of crude oil from each of our oilfields and the actual density of liquids produced at our gas processing plants. Hydrocarbon extraction expenses per barrel were calculated using these actual production volumes. Other operational indicators expressed in barrels were translated into barrels using an average conversion rate of 7.33 barrels per tonne. Translations of cubic meters to cubic feet were made at the rate of cubic feet per cubic meter. Translations of barrels of crude oil into barrels of oil equivalent ( BOE ) were made at the rate of 1 barrel per BOE and of cubic feet at the rate of 6 thousand cubic feet per BOE. This report includes forward-looking statements words such as believes, anticipates, expects, estimates, intends, plans, etc. that reflect management s current estimates and beliefs, but are not guarantees of future results. 2

3 Table of Contents Business overview... 4 Key financial and operational results... 5 Changes in Group structure... 5 Main macroeconomic factors affecting our results of operations... 6 International crude oil and refined products prices... 6 Domestic crude oil and refined products prices... 6 Changes in ruble exchange rate and inflation... 7 Taxation... 7 Transportation tariffs on crude oil, natural gas and refined products in Russia Segments highlights Exploration and production West Qurna-2 project Refining, marketing and distribution Financial results Sales revenues Operating expenses Cost of purchased crude oil, gas and products Transportation expenses Selling, general and administrative expenses Depreciation, depletion and amortization Equity share in income of affiliates Taxes other than income taxes Excise and export tariffs Foreign exchange loss Income taxes Non-GAAP items reconciliation Reconciliation of profit for the period to EBITDA Liquidity and capital resources Operating activities Investing activities Financing activities Other information Sectorial sanctions against the Russian companies Operations in Iraq

4 Business overview The primary activities of LUKOIL and its subsidiaries are crude oil exploration, production, refining, marketing and distribution. LUKOIL is one of the world s largest publicly traded vertically integrated energy companies in terms of hydrocarbon reserves and production. Our proved reserves under SEC standards amounted to 16.4 billion BOE at 1 January 2017 and comprised of 12.5 billion barrels of crude oil and 23.5 trillion cubic feet of gas. Most of our reserves are conventional. We undertake exploration for and production of crude oil and natural gas in Russia and internationally. In Russia, our major oil producing regions are Western Siberia, Timan-Pechora, Ural and Volga region. Our international upstream segment includes stakes in PSA s and other projects in Kazakhstan, Azerbaijan, Uzbekistan, Romania, Iraq, Egypt, Ghana, Norway, Cameroon, Nigeria and Mexico. Our daily hydrocarbon production in the first quarter of 2017 amounted to 2.2 million BOE with liquid hydrocarbons representing approximately 81% of our overall production volumes. LUKOIL has geographically diversified downstream assets portfolio primarily in Russia and Europe. Our downstream operations include crude oil refining, petrochemical and transport operations, marketing and trading of crude oil, natural gas and refined products, power generation, transportation and sales of electricity, heat and related services. We own and operate four refineries located in European Russia and three refineries located outside Russia in Bulgaria, Romania, and Italy. Moreover, we have a 45% interest in the Zeeland refinery in the Netherlands. We also own two petrochemical plants in Russia and petrochemical capacities at our refineries in Bulgaria and Italy. Along with our own production of refined products we refine crude oil at third party refineries depending on market conditions and other factors. Our refinery throughput in the first quarter of 2017 amounted to 1.3 million barrels per day, and we produced 0.3 million tonnes of petrochemicals. We are marketing our own and third-party crude oil and refined products through our wholesale and retail channels in Russia, Europe, South-East Asia, Central and North America and other regions. We own petrol stations in 18 countries. Most of our retail networks are located close to our refineries. Our retail sales in the first quarter of 2017 amounted to 3.3 million tonnes of refined products. We are involved in production, distribution and marketing of electrical energy and heat both in Russia and internationally. In the first quarter of 2017, our total output of electrical energy was 5.3 billion kwh. Our operations and finance activities are coordinated from our headquarters in Moscow. We divide our operations into three main business segments: Exploration and production, Refining, marketing and distribution and Corporate and other. 4

5 Key financial and operational results Change, % Sales... 1,431,599 1,177, EBITDA (1), including , , Exploration and production segment , ,586 (1.4) Refining, marketing and distribution segment... 70,527 63, EBITDA (1) net of West Qurna-2 project , , Profit for the period attributable to LUKOIL shareholders... 62,306 42, Capital expenditures , , Free cash flow (2)... 1,375 38,589 (96.4) Free cash flow before changes in working capital... 67,096 57, (thousand BOE per day) Production of hydrocarbons, including our share in equity affiliates... 2,244 2,413 (7.0) Crude oil and natural gas liquids... 1,822 2,006 (9.2) Gas Refinery throughput at the Group refineries... 1,319 1, (1) Profit from operating activities before depreciation, depletion and amortization. (2) Cash flow from operating activities less capital expenditures. In the first quarter of 2017, profit attributable to LUKOIL shareholders amounted to 62 billion RUB, an increase of 45.5% to the first quarter of Our financial results were supported by an increase in average hydrocarbon prices that was sizably offset by significant strengthening of the ruble. In the first quarter of 2017, our EBITDA amounted to 208 billion RUB, an increase of 8.2% to the first quarter of This increase was a result of an increase in share of high-margin volumes in crude oil production structure, better refineries slate, and a decrease in selling, general and administrative expenses. The increase was partially offset by the ruble appreciation and an increase in transportation tariffs. Our EBITDA was sizably affected by the decrease in volumes of compensation crude oil within the West Qurna-2 project. Net of this project, the Group s EBITDA increased by 20.1% compared to the first quarter of Our free cash flow amounted to 1 billion RUB, compared to 39 billion RUB in the first quarter of It was affected by an increase in working capital together with increase in our capital expenditures. The Group s average daily hydrocarbon production in the first quarter of 2017 decreased by 7.0% compared to the first quarter of 2016, which was primarily driven by lower volume of compensation crude oil from the West Qurna-2 project and production cuts driven by external limitations due to the agreement with OPEC. In the first quarter of 2017, production of refined products at own refineries increased by 2.5% compared to the first quarter of 2016 mainly due to the higher utilization rates at refineries in Perm, Volgograd and in Bulgaria. Changes in Group structure In December 2016, the Company entered into a contract with a company of the Otkrytie Holding group to sell the Group s 100% interest in JSC Arkhangelskgeoldobycha ( AGD ), a company developing the diamond field named after V.P. Grib located in Arkhangelsk region of Russia. The transaction s closing was subject to governmental approvals and was completed on 24 May The value of the transaction is the Russian ruble equivalent of $1.45 billion, including debt repayment by AGD to the Company, which can be subject to actual working capital adjustment at closing date. In February 2017, LUKOIL completed the sale of wholly owned subsidiary LUKOIL Chemical B.V., which owns Karpatneftekhim petrochemical plant located in Ivano-Frankovsk area of Ukraine. In line with the Company s strategy of optimizing its downstream operations in Europe, we sold petrol station networks in Poland, Latvia, Lithuania and Cyprus in

6 Main macroeconomic factors affecting our results of operations International crude oil and refined products prices The price at which we sell crude oil and refined products is the primary driver of the Group s revenues. The dynamics of our realized prices on international markets generally matches the dynamics of commonly used spot benchmarks such as Brent crude oil price, however our average prices are usually different from such benchmarks due to different delivery terms, quality mix, as well as specifics of regional markets in case of petroleum product sales. During the first quarter of 2017, the price for Brent crude oil fluctuated between $49 and $56 per barrel, reached its maximum of $56.3 in the end of February and then minimum of $49.2 in the end of March, and averaged 58.2% higher than in the first quarter of Nevertheless, as a result of the ruble appreciation, the prices expressed in rubles increased less significantly. The following tables show the average crude oil and refined product prices. Change, % (in US dollars per barrel, except for figures in percent) Brent crude Urals crude (CIF Mediterranean) Urals crude (CIF Rotterdam) (in US dollars per metric tonne, except for figures in percent) Fuel oil 3.5% (FOB Rotterdam) Diesel fuel 10 ppm (FOB Rotterdam) High-octane gasoline (FOB Rotterdam) Naphtha (FOB Rotterdam) Jet fuel (FOB Rotterdam) Vacuum gas oil (FOB Rotterdam) Source: Platts. Change, % (in rubles per barrel, except for figures in percent) Brent crude... 3,159 2, Urals crude (CIF Mediterranean)... 3,090 2, Urals crude (CIF Rotterdam)... 3,052 2, (in rubles per metric tonne, except for figures in percent) Fuel oil 3.5% (FOB Rotterdam)... 17,072 10, Diesel fuel 10 ppm (FOB Rotterdam)... 28,184 23, High-octane gasoline (FOB Rotterdam)... 32,060 28, Naphtha (FOB Rotterdam)... 28,281 23, Jet fuel (FOB Rotterdam)... 30,004 25, Vacuum gas oil (FOB Rotterdam)... 20,733 16, Translated into rubles using average exchange rate for the period. Domestic crude oil and refined products prices Most of the crude oil in Russia is produced and then refined or exported by vertically integrated oil companies. As a result, there is no liquid spot market for crude oil in Russia and no publicly available spot price benchmark. Domestic prices may deviate significantly from export netbacks and they also vary between different regions of Russia driven by supply demand balance on regional markets. Domestic prices for refined products correlate to some extent with export netbacks, but are also materially affected by supply demand balance on regional markets. 6

7 The table below represents average domestic wholesale prices of refined products. Change, % (in rubles per metric tonne, except for figures in percent) Fuel oil... 9,682 4, Diesel fuel... 31,453 27, High-octane gasoline (Regular)... 35,387 31, High-octane gasoline (Premium)... 35,233 33, Source: InfoTEK (excluding VAT). Changes in ruble exchange rate and inflation A substantial part of our revenue is either denominated in US dollars or euro or is correlated to some extent with US dollar crude oil prices, while most of our costs are settled in Russian rubles. Therefore, a devaluation of the ruble against the US dollar and euro generally causes our revenues to increase in ruble terms, and vice versa. Ruble inflation also affects the results of our operations. The following table provides data on inflation in Russia and change in the ruble-dollar and ruble-euro exchange rates. Ruble inflation (CPI), % Ruble to US dollar exchange rate Average for the period At the beginning of the period At the end of the period Ruble to euro exchange rate Average for the period At the beginning of the period At the end of the period Source: CBR, Federal State Statistics Service. Taxation In , the Russian Government is implementing the tax manoeuvre in the oil industry which envisages reduction of export duty rate and increase in the crude oil extraction tax and excise tax rates. Changes within this tax manoeuvre effective from January and April 2016 had a negative impact on our upstream, refining and marketing margins. Changes effective from January 2017 had a positive impact on our upstream margins and a negative impact on our refining and marketing margins, while overall impact of tax changes on our financial results wasn t significant. The following tables represent average enacted rates for taxes specific to the oil industry in Russia for the respective periods. Change, % (in US dollars per tonne, except for figures in percent) Export duties on crude oil Export duties on refined products Light and middle distillates Fuel oil Gasoline (22.7) Straight-run gasoline Diesel fuel Mineral extraction tax (1) Crude oil Natural gas (Nakhodkinskoe field) (1) Translated from rubles using average exchange rate for the period. 7

8 Change, % (in rubles per tonne, except for figures in percent) Export duties on crude oil (1)... 5,086 4, Export duties on refined products (1) Light and middle distillates... 1,524 1,641 (7.1) Fuel oil... 5,086 3, Gasoline... 1,524 2,500 (39.1) Straight-run gasoline... 2,795 2,911 (4.0) Diesel fuel... 1,524 1,641 (7.1) Mineral extraction tax Crude oil... 7,961 4, Natural gas (Nakhodkinskoe field) (1) Translated to rubles using average exchange rate for the period. The table below illustrates the impact of tax incentives for different fields and deposits in our portfolio at $50 per barrel Urals price. Under 2017 tax formulae Mineral extraction tax Export duty Total As % of oil price (in US dollars per barrel, except for figures in percent) Standard Yaregskoye field Yu. Korchagin field V. Filanovsky field Usinskoye (Permian layers) Pyakakhinskoye field V. Vinogradov field Highly depleted fields Small sized fields Tyumen deposits The rates of taxes specific to the oil industry in Russia are linked to international crude oil prices and are changed in line with them. The methods to determine the rates for such taxes are presented below. Crude oil extraction tax rate is changed monthly. Crude oil extraction tax is payable in rubles for metric tonnes extracted and is calculated according to the formula below: Exchange Rate Rate = Base Rate (Price 15) Incentive + Fixed Component, 261 where Price is a Urals blend price in US dollars per barrel and Exchange Rate is an average ruble exchange rate to US dollar during the period. The Base Rates and Fixed Components (where applicable) are presented below: (in rubles) Base Rate Fixed Component There are different types of tax Incentives on the mineral extraction tax on crude oil applied to our fields and deposits: A special reducing coefficient is applied to the standard tax rate depending on location, depletion, type of reserves, size and complexity of a particular field. This type of incentive with different coefficients is applied to our highly depleted fields (more than 80% depletion), our Yu. Korchagin field located in the Caspian offshore, the Permian layers of our Usinskoye field in Timan-Pechora producing high-viscous crude oil, our Pyakyakhinskoye field located in the Yamal-Nenets region of Western Siberia, a number of fields in the Nenets Autonomous region, as well as to our new small-sized fields (recoverable reserves less than 5 million tonnes) and fields and deposits with low permeability like V.N. Vinogradov field and Tyumen deposits; 8

9 A fixed tax rate of 15% of the international Urals price is applied to our V. Filanovsky field, located in the Caspian offshore; A zero tax rate is applied to our Yaregskoye field producing extra-viscous crude oil, as well as to unconventional deposits (Bazhenov and others). Some of the mineral extraction tax incentives are limited in time or by cumulative oil production volumes. The table on the p. 8 illustrates the impact of crude oil extraction tax incentives on the tax rate at $50 per barrel Urals price. The tax rate is zero when the average international Urals price is less than, or equal to, $15.00 per barrel. In the first quarter of 2017, each $1.00 per barrel increase in the international Urals price above $15.00 per barrel results in an increase in the tax rate by $0.48 per barrel ($0.45 per barrel in the first quarter of 2016). Natural gas extraction tax rate is calculated using a special formula depending on average wholesale natural gas price in Russia, share of gas production in total hydrocarbon production, regional location and complexity of particular gas field. Associated petroleum gas and reinjected natural gas are subject to zero extraction tax rate. Crude oil export duty rate is denominated in US dollars per tonne of crude oil exported and is calculated on a progressive scale according to the table below. International Urals price Less than, or equal to, $109.5 per tonne ($15 per barrel) Above $109.5 but less than, or equal to, $146 per tonne ($20 per barrel) Above $146 but less than, or equal to, $182.5 per tonne ($25 per barrel) Above $182.5 per tonne ($25 per barrel) Export duty rate $0 per tonne 35% of the difference between the actual price and $109.5 per tonne (or $0.35 per barrel per each $1 increase in the Urals price over $15) $12.78 per tonne plus 45% of the difference between the actual price and $146 per tonne (or $1.75 plus $0.45 per barrel per each $1 increase in the Urals price over $20) : $29.2 per tonne plus 42% of the difference between the actual price and $182.5 per tonne (or $4 plus $0.42 per barrel per each $1 increase in the Urals price over $25) Starting from 1 January 2017: $29.2 per tonne plus 30% of the difference between the actual price and $182.5 per tonne (or $4 plus $0.3 per barrel per each $1 increase in the Urals price over $25) The export duty rate changes every month with the rate for the next month being based on average Urals price for the period from the 15th day of the previous month to the 14th day of the current month. This calculation methodology results in the so-called export duty lag effect, when export duty rate lags the oil price changes, which may result in sizeable impact on our financial results in the periods of high oil price volatility. The table below illustrates the impact of the export duty lag effect on the Urals price net of taxes. Change, % (in US dollars per barrel, except for figures in percent) Enacted export duty on crude oil Lag effect (0.69) (135.0) Urals price (Argus) Net Urals price (1) Net Urals price (1) assuming no lag (1) Urals price net of export duty and crude oil extraction tax. Crude oil produced at some of our fields is subject to special export duty rates calculated according to special formulas, which are lower than standard rates. A reduced rate is applied to crude oil produced at our Yaregskoye field producing extra-viscous crude oil and our Yu. Korchagin field in the Caspian offshore. A zero rate applies to crude oil of our V. Filanovsky field also located in the Caspian offshore. 9

10 The table on the p. 8 illustrates the impact of crude oil export duty incentives on the duty rate at $50 per barrel Urals price. Export duty rates on refined products are calculated by multiplying the current crude oil export duty rate by a coefficient according to the table below and further 2016 Multiplier for: Light and middle distillates Diesel fuel Gasolines Straight-run gasoline Fuel oil Crude oil and refined products exports from Russia are subject to two steps of customs declaration and duty payments: temporary and complete. A temporary declaration is submitted based on preliminary exports volumes and the duty is paid in rubles translated from US dollars at the date of the temporary declaration. A complete declaration is submitted after receiving the actual data on the exported volumes, but no later than six months after the date of the temporary declaration. The final amount of the export duty is adjusted depending on the actual volumes, the US dollar exchange rate at the date of the complete declaration (except for pipeline deliveries when the exchange rate at the temporary declaration date is used) and the export duty rate. If temporary and complete declarations are submitted in different reporting periods, the final amount of the export duty is adjusted in the period of submission of the complete declaration. The high volatility of the ruble-dollar exchange rates may lead to significant adjustments. For the purposes of the IFRS consolidated financial statements, data from temporary declarations at the reporting period end is translated to rubles from US dollars using the period-end exchange rate. Crude oil and refined products exported to member countries of the Customs Union in the Eurasian Economic Union of Russia, Belarus, Kazakhstan, Armenia and the Kyrgyz Republic (Customs Union) are not subject to export duties. Excise on refined products. The responsibility to pay excises on refined products in Russia is imposed on refined product producers (except for straight-run gasoline). Only domestic sales volumes are subject to excises. In other countries where the Group operates, excises are paid either by producers or retailers depending on the local legislation. Excise rates on refined products in Russia are tied to the ecological class of fuel. Excise tax rates for the first quarter of 2017 and 2016 are listed below. Change, % (in rubles per tonne, except for figures in percent) Gasoline Below Euro ,100 10, Euro ,130 7, Diesel fuel All ecological classes... 6,800 4, Motor oils... 5,400 6,000 (10.0) Straight-run gasoline... 13,100 10, Excise tax rates starting from 2017 are listed below and further (in rubles per tonne) Gasoline Below Euro ,100 13,100 13,100 Euro ,957 10,535 10,130 Diesel fuel All ecological classes... 7,355 7,072 6,800 Motor oils... 5,400 5,400 5,400 Straight-run gasoline... 13,100 13,100 13,100 10

11 Income tax. Until 2017, the federal income tax rate was 2.0% and the regional income tax rate varied between 13.5% and 18.0%. In , the federal income tax rate is 3.0% and the regional income tax rate may vary between 12.5% and 17.0%. The Company and its Russian subsidiaries file income tax returns in Russia. A number of Group companies in Russia are paying income tax as a consolidated taxpayers group ( CTG ). This allows taxpayers to offset taxable losses generated by certain participants of a CTG against taxable profits of other participants of the CTG. The Group s foreign operations are subject to taxes at the tax rates applicable to the jurisdictions in which they operate. Transportation tariffs on crude oil, natural gas and refined products in Russia Many of our production assets are located relatively far from our customers. As a result, transportation tariffs are an important factor affecting our profitability. Сrude oil produced at our fields in Russia is transported to refineries and exported primarily through the trunk oil pipeline system of the state-owned company, Transneft. In some cases, crude oil is also transportated via railway infrastructure of the state-owned company, Russian Railways. Refined products produced at our Russian refineries are transported primarily by railway (Russian Railways) and the pipeline system of Transnefteproduct, a subsidiary of Transneft. Gas that is not sold at the wellhead is transported by the Unified Gas Supply System owned and operated by Gazprom. Transneft, Russian Railways and Gazprom are state-controlled natural transportation infrastructure monopolies and their tariffs are regulated by the Federal Antimonopoly Service of Russia and set in rubles. The following table sets forth the changes in the average tariffs charged by the state-controlled transportation service providers in Russia. 1 st quarter of 2017 to 4 th quarter of st quarter of 2017 to 1 th quarter of 2016 Transneft Crude oil % 3.3% Transnefteproduct Refined products % 7.8% Russian Railways Crude oil and refined products % 6.0% 11

12 Segments highlights Our operations are divided into three main business segments: Exploration and Production which includes our exploration, development and production operations related to crude oil and gas. These activities are primarily located within Russia, with additional activities in Azerbaijan, Kazakhstan, Uzbekistan, the Middle East, Northern and Western Africa, Norway, Romania and Mexico. Refining, Marketing and Distribution which includes refining, petrochemical and transport operations, marketing and trading of crude oil, natural gas and refined products, generation, transportation and sales of electricity, heat and related services. Corporate and other which includes operations related to our headquarters (which coordinates the operations of Group companies), finance activities, production of diamonds and certain other activities. Each of our segments is dependent on the other, with a portion of the revenues of one segment being a part of the costs of the other. In particular, our Refining, Marketing and Distribution segment purchases crude oil from our Exploration and Production segment. As a result of certain factors considered in the Domestic crude oil and refined products prices section on p. 6, benchmarking crude oil market prices in Russia cannot be determined with certainty. Therefore, the prices set for inter-segment purchases of crude oil reflect a combination of market factors, primarily international crude oil market prices, transportation costs, regional market conditions, the cost of crude oil refining and other factors. We present the financial data for each segment in Note 29 Segment information to our condensed interim consolidated financial statements. Exploration and production EBITDA in Russia ,059 97,688 EBITDA outside Russia (1)... 15,718 31,898 EBITDA , ,586 Hydrocarbon extraction expenses... 49,867 54,077 - in Russia... 42,952 39,711 - outside Russia (2)... 2,593 4,163 - in Iraq... 4,322 10,203 (ruble per BOE) Hydrocarbon extraction expenses (2) in Russia outside Russia (2) (US dollar per BOE) Hydrocarbon extraction expenses (2) in Russia outside Russia (2) (1) Including EBITDA of the West Qurna-2 project in the amounts of 2,943 million RUB and 21,494 million RUB in the first quarter of 2017 and 2016, respectively. (2) Excluding expenses at the West Qurna-2 field. Our upstream EBITDA was relatively flat to the first quarter of Our EBITDA in Russia was supported by the increase in crude oil prices, a shift in production structure towards high-margin projects, and a positive impact of tax maneuver. On the other hand, our upstream earnings were affected by a decrease in production volumes. Outside Russia, the decrease in EBITDA of the West Qurna-2 project and the effect of ruble appreciation outweighed the positive impact of crude oil price increase. 12

13 Crude oil and natural gas liquids production. In the first quarter of 2017, we produced (including the Company s share in equity affiliates) 21,802 thousand tonnes or million barrels of crude oil, compared to 24,495 thousand tonnes or million barrels of crude oil in the first quarter of In the first quarter of 2017, the output of natural gas liquids at the Group gas processing plants in Western Siberia, Ural and Volga regions of Russia was 3.0 million BOE, compared to 3.4 million BOE in the first quarter of (thousand BOE per day) Crude oil and natural gas liquids (1) Consolidated subsidiaries Western Siberia Timan-Pechora Ural region Volga region Other in Russia Total in Russia... 1,683 1,703 Iraq (2) Other outside Russia Total outside Russia Total consolidated subsidiaries... 1,761 1,947 Our share in equity affiliates in Russia outside Russia Total share in equity affiliates Total crude oil and natural gas liquids... 1,822 2,006 Natural and petroleum gas (3) Consolidated subsidiaries Western Siberia Timan-Pechora Ural region Volga region Other in Russia Total in Russia Total outside Russia Total consolidated subsidiaries Share in equity affiliates in Russia outside Russia Total share in production of equity affiliates Total natural and petroleum gas Total daily hydrocarbon production... 2,244 2,413 (1) Natural gas liquids produced at the Group gas processing plants. (2) Compensation oil that represented approximately 8% of production from the West Qurna-2 field in the first quarter of 2017 and 47% in the first quarter of (3) Natural and petroleum gas production less flaring, reinjection, and direction to Group s gas processing plants. 13

14 The following table presents our crude oil production in the first quarter of 2017 and 2016 by major regions. (thousands of tonnes) 3 months of 2017 Total, % Change to 2016 Change in structure Organic change 3 months of 2016 Western Siberia... 9,810 (6.0) (627) 10,437 Timan-Pechora... 4,002 (8.1) (352) 4,354 Ural region... 3,755 (0.5) (19) 3,774 Volga region... 2, ,628 Other in Russia (7.7) (35) 457 Crude oil produced in Russia... 20,178 (2.3) (472) 20,650 Iraq (1) (84.4) (2,196) 2,601 Other outside Russia (7.8) (44) 561 Crude oil produced outside Russia (70.8) (2,240) 3,162 Total crude oil produced by consolidated subsidiaries... 21,100 (11.4) (2,712) 23,812 Our share in crude oil produced by equity affiliates: in Russia outside Russia (4.2) (19) 457 Total crude oil produced... 21,802 (11.0) (2,693) 24,495 (1) Compensation oil that represented approximately 8% of production from the West Qurna-2 field in the first quarter of 2017 and 47% in the first quarter of The main oil producing region for the Company is Western Siberia where we produced 46.5% of our crude oil in the first quarter of 2017 (43.8% in the first quarter of 2016). In October 2016, we started commercial production at two new major fields, the V. Filanovsky field in the Caspian Sea (Volga region) and the Pyakyakhinskoye field in the Bolshekhetskaya depression (Western Siberia). These fields have a major positive impact on our financial results due to high quality reserve base and tax incentives. In the first quarter of 2017, the Group produced 888 thousand tonnes of crude oil at the V. Filanovsky field and 348 thousand tonnes of liquids at the Pyakyakhinskoye field. A decrease in our production volumes in the first quarter of 2017 was mainly a result of an external limitation due to an agreement of OPEC and some of the non-opec countries, including Russia, to cut production from October 2016 levels in order to stabilize the global crude oil market. We limited production in our traditional regions (Western Siberia, Timan-Pechora, Ural), while we continued ramping up production at the V. Filanovsky and Pyakyakhinskoye fields. Moreover, crude oil production in Timan- Pechora was affected by weather conditions. The decrease in our international production was a result of lower volumes of production from the West Qurna-2 oilfield in Iraq attributable to the Company. We were compensated for most of the costs incurred within the construction stage of the project and therefore were eligible for less volumes of compensation crude oil (for details see p. 15). The increase in our share in crude oil produced by equity affiliates in Russia was due to an increase in production at the Trebs and Titov oilfields by Bashneft-Polus, where the Group holds a 25.1% interest. Gas production. In the first quarter of 2017, we produced (including our share in equity affiliates) 6,459 million cubic meters (38.0 million BOE) of gas, that is 2.8% more than in the first quarter of The following table presents our gas production (excluding flaring, reinjected gas and gas used in production of natural gas liquids) by major regions. 14

15 (millions of cubic meters) 3 months of 2017 Total, % Change to 2016 Change in structure Organic change 3 months of 2016 Western Siberia... 3, ,930 Timan-Pechora Ural region (2.9) (8) 266 Volga region (12.7) (43) 340 Other in Russia... 8 (9.9) (1) 9 Gas produced in Russia... 4, ,035 Gas produced outside Russia... 1,924 (5.3) (108) 2,032 Total gas produced by consolidated subsidiaries... 6, ,067 Our share in gas produced by equity affiliates: in Russia outside Russia Total gas produced... 6, ,281 Our major gas production field is the Nakhodkinskoe field in Western Siberia, which is in natural decline. In January 2017, we started natural gas production at the Pyakyakhinskoye field in Western Siberia, which substantially contributed to our overall gas production in Russia. In the first quarter of 2017, our gas production at the Nakhodkinskoe and the Pyakyakhinskoye fields was 2,109 million cubic meters of natural gas (1,850 million cubic meters in the first quarter of 2016). Our international gas production (including our share in affiliates production) decreased by 4.7%, compared to the first quarter of West Qurna-2 project The West Qurna-2 field in Iraq is one of the largest crude oil fields discovered in the world, with estimated recoverable oil reserves of 12.9 billion barrels (1.8 billion tonnes). Service agreement for the West Qurna- 2 field development and production was signed on 31 January Currently, the parties of the project are Iraq s state-owned South Oil Company and a consortium of contractors, consisting of a Group company (75% interest) and Iraq s state-owned North Oil Company (25% interest). The Group launched the Mishrif Early Oil stage on the West Qurna-2 field and reached the production of 120 thousand barrels per day in March According to the service agreement, starting from the second quarter of 2014, we receive cost compensation. The project s target production level is 1.2 million barrels per day and the total term of the contract is 25 years. Accounting for the cost compensation within the West Qurna-2 project in our consolidated statement of financial position and consolidated statement of profit or loss and other comprehensive income is as follows. Capital expenditures are recognized in Property, plant and equipment. Extraction expenses are recognized in Operating expenses in respect of all the volume of crude oil production at the field regardless of the volume of compensation crude oil the Group is eligible for. As the compensation revenue is recognized, capitalized costs are amortized. There are two steps of revenue recognition: The Iraqi party, on a quarterly basis, approves invoice for cost recovery and remuneration fee for which the Group is eligible in the reporting period. Amount of the invoice depends on crude oil production volumes during the period and current crude oil market prices. Approved invoice amount and the remuneration fee for the reporting quarter are recognized in crude oil sales revenue. Based on the approved invoices, the Iraqi party arranges schedule of crude oil shipments against its liability for cost compensation and remuneration. As this crude oil is actually shipped, its cost is recognized at current market price in Cost of purchased crude oil, gas and products. Further, revenue from sales of this crude oil, or products from its refining, is recognized in Sales. Unsold crude oil and refined products are recognized in Inventories. The following table summarizes data on capital and operating cost incurred, compensation crude oil received, costs yet unrecovered and remuneration fee. 15

16 Сosts incurred (1) Remuneration fee Crude oil received Crude oil to be received (millions of US dollars) Cumulative at 31 December , , Change during the first quarter of (14) Cumulative at 31 March , , (1) Including prepayments. The amount of remuneration within the West Qurna-2 project decreased approximately threefold since February 2017 following the provisions of the service contract due to lower than target production volumes. The West Qurna-2 project s summary is presented below: (thousand barrels) (thousand (thousand tonnes) barrels) (thousand tonnes) Total production (1)... 35,960 5,242 38,018 5,542 Production related to cost compensation and remuneration (1)... 2, ,840 2,601 Shipment of compensation crude oil (1) (2)... 2, ,527 2,555 (millions of rubles) (millions of US dollars) (millions of rubles) (millions of US dollars) Cost compensation (3)... 6, , Remuneration fee... 1, , , , Cost of compensation crude oil, received as liability settlement (included in Cost of purchased crude oil, gas and products) (2)... 8, , Extraction expenses... 4, , Depreciation, depletion and amortization... 2, , EBITDA... 2, , Capital expenditures... 2, , (1) Translated into barrels using conversion rate characterizing the density of the field. (2) This crude oil is sold to third party customers or delivered to our refineries. After realization of these products, respective sales revenues are recognized. (3) Excluding deferred income in the amount of $17 million in the first quarter of Refining, marketing and distribution The following table summarized key figures on our Refining, marketing and distribution segment: EBITDA in Russia... 37,847 43,893 EBITDA outside Russia... 32,680 19,617 EBITDA... 70,527 63,510 Refining expenses at the Group refineries... 21,011 22,450 - in Russia... 10,149 10,135 - outside Russia... 10,862 12,315 (ruble per tonne) Refining expenses at the Group refineries... 1,297 1,420 - in Russia ,009 - outside Russia... 1,909 2,137 (US dollar per tonne) Refining expenses at the Group refineries in Russia outside Russia

17 Our domestic refineries earnings in the first quarter of 2017 were negatively impacted by the changes in export duties and excise rates within the tax maneuver that was partially offset by increased production volumes, better product slate as a result of completed modernization program and continued throughput optimization. At the same time, our retail earnings in Russia were affected by an increase in excise rates. Outside Russia, refineries earnings were positively impacted by the increase in refining margins and better product slate. Refining and petrochemicals The following table summarizes key figures for our refining volumes: (thousands of tonnes) Refinery throughput at the Group refineries... 16,196 15,812 - in Russia... 10,506 10,048 - outside Russia, including... 5,690 5,764 - crude oil... 5,119 4,428 - refined products ,336 Refinery throughput at third party refineries... 1, Total refinery throughput... 17,592 15,904 Production of the Group refineries in Russia... 9,911 9,453 - diesel fuel... 3,678 3,247 - gasoline... 1,832 1,806 - fuel oil... 1,499 1,556 - jet fuel lubricants and components straight-run gasoline vacuum gas oil ,037 - bitumen coke other products Production of the Group refineries outside Russia... 5,327 5,414 - diesel fuel... 2,312 2,294 - gasoline... 1,207 1,167 - fuel oil jet fuel straight-run gasoline vacuum gas oil coke other products Refined products produced by the Group... 15,238 14,867 Refined products produced at third party refineries... 1, Total refined products produced... 16,616 14,955 Products produced at petrochemical plants and facilities in Russia outside Russia Compared to the first quarter of 2016, the total volume of refined products produced by the Group increased by 2.5%. In Russia, our production volumes increased by 4.8% due to higher utilization rates at Perm and Volgograd refineries. We redirected dark products produced at Perm and Ukhta refineries from export deliveries to supply catalytic cracking unit at our refinery in Nizhny Novgorod and also partially substituted purchased additives with additives of own production that resulted in optimization of operating expenses. Internationally, the production decreased by 1.6% due to maintenance works at our refineries in Bulgaria and Romania. In the periods considered, we processed our crude oil at third party refineries in Belarus and Kazakhstan. Moreover, in the end of 2016, a Group company entered into a processing agreement with a Canadian refinery. In the first quarter of 2017, attributable refined products output amounted to 1,336 thousand tonnes. The agreement is valid through

18 Marketing and trading In addition to our production, we purchase crude oil in Russia and on international markets. In Russia, we primarily purchase crude oil from affiliated producing companies and other producers. Then we either refine or export purchased crude oil. Crude oil purchased on international markets is normally used for trading activities, for supplying our international refineries or for processing at third party refineries. In Russia, we purchase refined products on occasion, primarily to manage supply chain bottlenecks. Refined products purchases outside Russia are either traded or supplied to our international refineries. We undertake trading operations on international markets through our 100% subsidiary LITASCO. We use traditional physical volumes hedging techniques to hedge our trading operations to secure trading margin. The following table shows the volumes of crude oil purchases by the Group during the periods considered. (thousands of tonnes) Crude oil purchases in Russia for trading internationally... 7,637 6,295 for refining internationally... 5,613 3,342 Shipment of the West Qurna-2 compensation crude oil ,555 Total crude oil purchased... 13,932 12,400 The table below summarizes figures for our refined products marketing and trading activities. (thousands of tonnes) Retail sales... 3,316 3,239 Wholesale sales... 28,634 26,237 Total refined products sales... 31,950 29,476 Refined products purchased in Russia Refined products purchased internationally... 16,115 15,387 Total refined products purchased... 16,551 15,771 In 2016, in line with the strategy to optimize our downstream operations, a Group company sold distribution companies operating in Poland, Lithuania, Latvia and Cyprus. Exports of crude oil and refined products from Russia. The volumes of crude oil and refined products exported from Russia by our subsidiaries and export revenues (both to the Group companies and third parties) are summarized as follows: (thousands of tonnes) Exports of crude oil to Customs Union Exports of crude oil beyond Customs Union... 8,770 7,873 Total crude oil exports... 9,405 8,855 EExports of crude oil through Transneft and other third party infrastructure... 7,100 6,942 including volumes exported through ESPO pipeline Exports or crude oil through the Group s transportation infrastructure... 2,305 1,913 Total crude oil exports... 9,405 8,855 Exports of crude oil to Customs Union... 10,673 12,410 Exports of crude oil beyond Customs Union , ,610 Total crude oil exports , ,020 18

19 (thousands of tonnes) Refined products exports - diesel fuel... 2,519 2,200 - gasoline fuel oil... 1, jet fuel motor oils gas refinery products other products ,367 Total refined products exports... 4,940 5,081 Total refined products exports ,659 89,849 In the first quarter of 2017, the volume of our crude oil exports from Russia increased by 6.2%, and we exported 46.6% of our domestic crude oil production (42.9% in the first quarter of 2016) and 116 thousand tonnes of crude oil purchased from our affiliates and third parties (105 thousand tonnes in the first quarter of 2016). The increase in export volumes was a result of lower domestic sales. The volume of our refined products exports decreased by 4.2% compared to the first quarter of Substantially, we use the Transneft infrastructure to export our crude oil. Nevertheless, a sizeable amount of crude oil is exported through our own infrastructure. All the volume of crude oil exported that bypassed Transneft was routed beyond the Customs Union. The Company also exports its light crude oil through the Caspian Pipeline Consortium and Eastern Siberia Pacific Ocean pipelines that allows us to preserve the premium quality of crude oil and thus enables us to achieve higher netbacks compared to traditional exports. Priority sales channels. We develop our priority sales channels aiming at increasing our margin on sale of refined products produced by the Group. In the first quarter of 2017, we sold 2.4 million tonnes of motor fuels via our domestic retail network, that represented an increase of 9.9% against the first quarter of Outside Russia, retail sales decreased to 1.0 million tonnes, or by 12.2%, mostly as a result of divestment of our retail networks in Poland, the Baltic states and Cyprus. We also supply jet fuel to airports in and outside Russia and bunker fuel to sea and river ports in Russia. Power generation. We established a vertically integrated chain from generation to transportation and sale of power and heat for third party customers (commercial generation) and own consumption. We own commercial generation facilities in the Southern regions of European Russia. We also own renewable energy capacity in Russia and abroad. In the first quarter of 2017, our total output of commercial electrical energy was 5.3 billion kw-h (5.4 billion kw-h in the first quarter of 2016), and our total output of commercial heat energy was approximately 4.9 million Gcal (5.4 million Gcal in the first quarter of 2016). 19

20 Financial results The table below sets forth data from our consolidated statements of profit or loss and other comprehensive income for the periods indicated. Revenues Sales (including excise and export tariffs)... 1,431,599 1,177,674 Costs and other deductions Operating expenses... (107,492) (113,244) Cost of purchased crude oil, gas and products... (742,569) (537,733) Transportation expenses... (73,714) (86,699) Selling, general and administrative expenses... (36,286) (47,823) Depreciation, depletion and amortization... (80,774) (84,348) Taxes other than income taxes... (153,682) (83,553) Excise and export tariffs... (109,447) (114,949) Exploration expenses... (764) (1,681) Profit from operating activities , ,644 Finance income... 3,299 3,831 Finance costs... (9,470) (10,371) Equity share in income of affiliates... 3,730 2,353 Foreign exchange loss... (43,494) (45,378) Other expenses... (2,487) (3,343) Profit before income taxes... 78,449 54,736 Current income taxes... (12,756) (10,476) Deferred income taxes... (3,009) (1,290) Total income tax expense... (15,765) (11,766) Profit for the period... 62,684 42,970 Profit for the period attributable to non-controlling interests... (378) (145) Profit for the period attributable to PJSC LUKOIL shareholders... 62,306 42,825 Basic and diluted earnings per share of common stock attributable to PJSC LUKOIL shareholders (in Russian rubles) The analysis of the main financial indicators of the financial statements is provided below. 20